W.P. Carey (WPC 0.45%) has been a terrific dividend stock over the years. The real estate investment trust (REIT) had steadily increased its payout each year for nearly a quarter century.
However, that streak is ending following the diversified REIT's decision to accelerate its exit from the office sector. It intends to reset its payout (which currently yields 7.5%) to reflect its reduced cash flows and allow it to retain more money to invest in new properties. While painful in the near term, that plan could create more value for investors over the long run.
NYSE: WPC
Key Data Points
Digging into the decision
W.P. Carey has been slowly shifting its portfolio away from the office sector over the years. The REIT got 30% of its total annual base rent from office properties at the end of 2015. It has cut that in half over the years by selling off office properties and focusing new investments in other sectors like industrial and warehouses.
Instead of continuing its slow exit, the company opted to rip the band-aid off through a two-pronged strategy to get its office exposure down to around zero by early next year. It spun off 62 properties into a new pure play office REIT, Net Lease Office Properties. It's selling the remaining properties, which it expects will close by early next year.
CEO Jason Fox commented on the decision on the REIT's recent third-quarter conference call. He stated:
Proactively exiting our office exposure over a short period of time also ensures we won't face a drag in our earnings over multiple years or the risks associated with large lease expirations and increased vacancies driven by declining demand for office. Our view is that the leasing market, financing market and investment sales market for the office sector will all remain under pressure and that office assets will see worse outcomes going forward than they've seen in the past, which will be particularly impactful on a single-tenant office portfolio with a declining weighted average lease term. These factors all contributed to our conviction addressing office more proactively, while it still has a reasonable amount of lease term remaining and to provide investors a cleaner and clearer path for earnings growth on our core portfolio.
The company opted to take a one-time hit by exiting the office sector now rather than see those properties drag down its earnings over the next several years. It also believed its exposure to the office sector had been weighing on its valuation, which was toward the low end of its peer group in the net lease sector:
Image source: W.P. Carey.
A transition and then a reacceleration
W.P. Carey's decision to quickly exit the office sector will have a meaningful near-term impact. W.P. Carey expects its adjusted funds from operations (FFO) to fall from $5.17-$5.23 per share this year to between $4.60 and $4.80 per share next year. As a result, the company plans to reset its dividend. It's aiming for a dividend payout ratio in the low-to-mid 70% range of its adjusted FFO in the future (down from around 80% in 2023). "We expect that to translate to a one-time reduction of approximately 20% in the fourth quarter," stated CFO Toni Sanzone on the third-quarter call.
However, the REIT anticipates its adjusted FFO and dividend will grow faster from that reset base in the future. That reacceleration should start toward the end of next year. The company expects to receive about $2 billion in cash by early next year from selling its office properties, U-Haul's expected buyout of the self-storage properties it currently leases, and other property sales. That will give it the cash to pay debt as it matures and fund new higher-return investments. While those property sales will act as a headwind in the first half of the year, the redeployment of that capital will be a tailwind for growth in the latter half of the year and beyond.
Meanwhile, by exiting its office properties, the company's rental growth rate should improve as it benefits from inflation-linked rate increases and higher fixed-rate lease escalations from its other properties. These factors should drive faster adjusted FFO per share growth in 2025 and beyond.
That will benefit the dividend. Sanzone noted on the call that the REIT's "intention is to grow the dividend in line with our AFFO growth, which we anticipate will result in higher dividend growth than in recent years."
Positioned to produce higher total returns
W.P. Carey's high-yielding dividend made up most of its return over the years. However, that should change in 2025 and beyond. The company expects its accelerated exit from the office sector will enable it to grow its adjusted FFO faster in the future. That faster growth rate should help boost the REIT's valuation. Add in what will still be a reasonably attractive dividend (that should rise at a decent clip from its reset level in the future), and W.P. Carey could produce strong total returns in the coming years.
